Muni Bonds Are Hyped And Starting To Implode... Time To Loosen Credit Standards?

Everyone sees the signs of a bubble after the fact, but here’s a chance to see one ahead of it.Municipal bonds have become the favourites lately for yield-hungry investors, to the extent that many fear the asset class has already become a bit of a mini-bubble.

Investors might have become too enthusiastic about the tax-exempt yields on offer, forgetting that muni bonds can indeed default. Some issuers are in bad shape already, so things could already be starting to crack as it stands.

That’s why it’s just plain scary how Moody’s is now being pressured by politics to loosen their credit standards for munis:

Moody’s Investors Service plans in mid-April to move to a global scale for its municipal bond ratings so that they are more in line with its corporate debt ratings, after postponing the initiative during the height of the financial crisis.

The rating agency’s announcement of the move came a day after Senate Banking Committee chairman Christopher Dodd, D-Conn., unveiled a redrafted financial regulatory reform proposal that would mandate such changes, similar to the reform bill the House passed in December.

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Moody’s said yesterday that it will take about four weeks to fully replace all of its 70,000 “sale-level” ratings for outstanding muni bond issues of 18,000 issuers.

While Moody’s has been criticised for having a muni bond ratings system that was unfairly more strict than that for corporate bonds, shouldn’t they be adjusting their corporate bond rating methodology up to match their more strict muni bond methodology? That’s the prudent way to bring everything in line under one system.

Rather, they are taking the easy way out, adjusting their muni standards down to meet the more lax level of corporates, making everything equally loose and pleasing politicians who want muni issuers to pay less interest rates during hard times (through better credit ratings, if markets believe the new ratings). Yet this kind of self-reinforcing ‘everybody wins’ laxness just seems eerily familiar.

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